Understanding the Marketplace

In the previous article we looked at the basics of how insurance markets, and particularly health care insurance, are organized. We saw that there are a number of issues that indicate that this is not simple:

Companies must be able to make a profit or they won’t stay in the market. This is something I usually covered in Semester 1 of Economics back when I was teaching, and it really is Economics 101 stuff.

Companies make a profit by keeping revenues above costs. This can mean raising prices or cutting costs as needed. In insurance markets, it means raising premiums or denying benefits.

Insurance markets involve “betting” on future events. Basically, when you buy a policy you are “betting” something bad is going to happen that will require a benefit payment, and the insurance company is “betting” that it won’t happen.

Insurance companies make this work by pooling risks. They don’t necessarily know which person will make a claim, but they know that out of millions of policy holders roughly how many will file a claim.

So, with this as a starting point, what can we say about the Health Insurance marketplace?

History

In the United States, most people with health insurance coverage get it as a benefit from their employer. This is kind of accidental really, and comes from WWII. During the war, labor was scarce (all those soldiers in Europe and the Pacific), and government price controls prevented any wage increases that might have drawn in additional workers. Providing health insurance as a benefit was allowed, however, and so the process began.

Now, one thing this story should make clear is that this is a cost to the employer, and is part of the wage costs that employers look at. And as health costs rose in the last few decades, employers started to look for ways to reduce their costs. This has meant something referred to as cost shifting, meaning more of the costs are shifted to the employee. And as costs rose smaller employers were more likely to not offer insurance at all, or find ways to restrict who could get it, such as limiting it by job class or hours worked. This left more workers without insurance.

In 1965 the government passed a program called Medicare, that initially was targeted at providing insurance to elderly people who would otherwise not have it. It was later expanded to include certain types of disabled people. The same legislative package created Medicaid, which was targeted at people who were receiving cash assistance from the government.

What all of these provisions have in common is a large role for the private sector. Employer-provided health insurance is purchased from private companies, who need to to be actuarially sound and make a profit. Medicare and Medicaid are not required to make a profit, but do need to be actuarially sound. And all three programs simply pay for the services rendered by doctors and hospitals.

Another common feature of all three is that they do a pretty good job of pooling risk. A large company might offer many thousands of employees in a batch to an insurance company, making the pool profitable to the company. Some people would have health issues, but others wouldn’t, and the employer would pay the same premium for all of them. So for a company they might have someone in their 50s experiencing health problems, but also some people in their 20s with very few problems, and the employer would pay the same premium for all of them. With Medicare and Medicaid this doesn’t work the same since almost by definition you are dealing with a less-healthy population on average. But there is still pooling of risk going on in these programs, and the pools are significantly larger (millions instead of thousands).

Providers

In any market analysis you need to look at both sides of the market, both the supply and the demand. The supply comes from what are called providers in this market, generally doctors and hospitals (though there are labs, providers of Durable Medical Equipment, ambulances, etc.). Doctors are also primarily for-profit, whereas hospitals have a very significant non-profit component. However, the evidence shows that care is about the same level of quality either way, and finances are pretty similar. For either doctors or hospitals, they need to cover all of their costs plus some margin that may be called profit, or fund balance, or whatever. This is where the money comes from to invest in new facilities, equipment, and so on.

Doctors have the ability to decide who they will take as patients, and health insurance is a definite factor. In health insurance the payments that doctors and hospitals get are called reimbursement, the idea being that they have incurred costs that they need to be reimbursed for. If reimbursement rates are too low for a given payor (i.e. insurance company or government) they may refuse to take those patients. This is why you may need to shop around for a doctor who will take your insurance.

Hospitals are a little different. They usually have contracts with all of the major insurers, and with the government, but you can still get caught if you go to a hospital your insurer doesn’t approve of. But the biggest difference is that hospitals are legally required to take emergency cases at least up to the point where the patient is stabilized. That can result in what they call uncompensated care. Does that mean they never get any payment? No, it doesn’t. Both the government and the major insurers will allow hospitals to claim compensation to cover that, so at least some of those costs are recovered. So if you have people using the emergency room, they cannot be turned away, but they are using the most expensive form of medical care, and the costs are being passed back to either taxpayers or to insurance premiums, because insurance companies are not charities.

So, with this information we can start to look into the tradeoffs involved in the funding of health care U.S.-style.